Coporate world: Forms and types of business
The structure of a business influences many things such as legal structure, tax, day-to-day activities liability and assets etc.
You have to decide the type and form of business you want for your startup to enable you to make the right decisions for your new business.
Your decision will have impacts on different aspects of the business such as the amount of paperwork you will be required to make for your business, how you generate revenue as well as personal liability.
You should also know the advantages and disadvantages of the business structure you are opting for. Remember, this is a decision that would have long-term implications; thus, you need not rush that step.
It would help to consult a professional that is knowledgeable in the field to assist you when forming your business.
Things to take into account when choosing a business type
Here are things you might want to take into account when forming a new business:
- The level of control you wish to have over the business
- A feasible vision for the nature and size of the business
- Your ability to deal with the bad sides or disadvantages of the business type
- Tax implications for the organizational structure
- The vulnerability of the business to lawsuits
- Your expected profit (and loss) from the business
Now, let's look at the different types or structure of businesses.
Forms of business organization
Here are the different types of business structures operational today.
Most small and medium-size businesses start as sole proprietorships. If you want to be the sole owner of your business, then you should consider this business type because it enables you to operate your business solely without a third party.
With this type of business, you alone have the right to make decisions as regards your business, and the day-to-day running of the company is your responsibility.
In sole proprietorship, the business owner solely runs the business and takes all decisions concerning the business
Examples of sole proprietors are home-based private businesses owned by single individuals, independent contractors and freelancers.
Advantages of sole proprietorship
- All business profits go to the owner
- It is the easiest type of business to organize
- It is less expensive to organize and run
- The owner has the liberty to make all decisions concerning his business and is in total control of the company (this could be a disadvantage though)
- Business profits are taxed only once
Disadvantages of sole proprietorship
- It has no separate legal status.
- Means of raising funds or capital is more limited.
- There is an unlimited liability if something bad befalls the business. Personal assets would be at risk in the case of a lawsuit.
Partnership is the type of business whereby two or more people share the ownership of a single business. Just as it is with the case of sole proprietorship, there is no separate legal status here. That is to say; the law doesn't distinguish between the business and the business owners.
However, the partners would have to process legal agreement papers which would indicate how decisions will be made; disputes will be resolved, profits will be shared, how more partners would be admitted in the future and even how the partnership will be dissolved if need be for that.
Forms of business organisations
Partnerships are of two types- general partnerships and limited partnership
In general partnerships, all the partners are responsible for managing the company and share responsibility for the partnerships' obligations as well as debts. It is generally easier to form than the other type of partnership- limited partnership.
Limited partnership has both general and limited partners. While the general partners assume liability for the partnership and operate the business fully, the limited partners serve as investors only.
The limited partners here have no control over the company and are not subject to the same liabilities as the general partners.
Warning: If you are establishing a partnership, especially with a friend or family, ensure that everything is outlined legally just in case things go sour.
You can seek legal advice and services to assist you.
Advantages of partnership
- Profits are taxed only once
- The partners are likely to have skills and attributes that complement each other
- Partners can bring together great ideas that will help the business move forward
- It is also easy to establish when compared to some other type of business
Disadvantages of partnership
- Decision making might take longer time as opinions are likely to differ amongst parties
- Partners are individually and jointly liable for the actions of other partners.
- Profit made from the business will have to be shared amongst partners.
- The business might suffer if a detailed partnership agreement is not put in place.
The law considers a corporation a separate legal entity; an entity separate from its owner. This means that unlike the case of sole proprietorship and partnership, a corporation can be sued, taxed and can even enter contractual agreements.
A corporation has its own life separate from that of the owners and doesn't dissolve even when ownership changes.
There are three main types of corporations - C-corporation and S-corporation and Limited Liability Company which recently gained popularity among entrepreneurs.
This is also sometimes referred to as 'C corp'. It is a legal entity that is separate from its owners. The corporation can be taxed, can make a profit and can be held liable legally.
Unlike what is obtainable with the sole proprietorship, corporations offer its owners strong protection from personal liability; however, it costs more to form this type of business structure as it is higher than other structures.
Unlike partnerships, sole proprietorships and Limited Liability Company, C corps pay income tax on their profits. Also, corporate profits are taxed twice in some cases (when the company makes a profit and when shareholders receive dividends on their personal tax returns).
C corps are independent of their shareholders. The business continues without disruption when a shareholder leaves the company or sells his or her shares.
It is a better choice for medium and higher-risk businesses or businesses that need to raise huge capital.
Advantages of C-Corporation
- Offers limited liability
- Tax benefits
- Transfer of business ownership doesn't disrupt business
- Shareholders can sell their shares
- It is easier to raise funds through the sale of stocks
Disadvantages of C-Corporation
- It is not easy to form
- It would cost more to establish a business corporation
- It requires more administrative roles such as the holding of meetings, keeping minutes of meetings etc
- Taxes are paid more than once
This business structure is also known as subchapter S-corporation and offers limited liability to owners. Small business owners prefer this to the regular (C) corporation as it has some appealing tax benefits and still provides liability protection.
In the case of S-corporation., the income and losses are passed through to shareholders via there individual tax returns. Also, this type of corporation is designed to avoid double taxation as seen with C corps.
Just like C corps, S corps operate as separate legal entities, and when a shareholder sells his or her shares, the business won't be disrupted. Shareholders here are limited to 100.
Corporation business structure requires more administrative roles
An S-corporation is not required to pay income taxes; rather, profits and earnings would be treated as distributions. Shareholders here are mandated to report their income on their individual income tax returns.
Advantages of S-Corporation
- Limited liability
- There is no double taxation as in the case of C-corporation
- It enables the transfer of ownership
- Profits are taxed once only
- Capital can be easily raised through the sale of stocks
Disadvantages of S-Corporation
- The business structure is costly to form
- It requires more administrative duties
- Stockholders are limited to estates, individuals or trustees
- Unlike C corps, S corps can only offer one class of stock which can hinder the company's ability to raise capital
Limited Liability Company (LLC)
This is a hybrid business structure that combines some features of a corporation and that of partnerships and sole proprietorships. It combines the limited legal liability of a corporation and the operational flexibilities of the sole proprietorship or partnership.
Formation of an LLC is more complicated than that of a general partnership. This business type is designed to offer business owners liability protection but without the double taxation.
Profits and losses here are added to the personal tax returns of owners. This sounds similar to S-corporation. However, LLC offers even more attractive benefits to business owners than the S corp.
For instance, there is no limit to the number of shareholders in this type of corporation, unlike the S-corporation that has a limit of 100 shareholders. Also, every member has the right to participate fully in the business operations
Advantages of Limited Liability Company
- It is the most common of the corporation structures
- It supports small businesses
- It operates as a legal entity
- it must have insurance in case of a lawsuit
- Shareholders are unlimited
- It is taxed as a sole proprietorship
Disadvantages of Limited Liability Company
- It is costly to form
- Personal tax liability
- The cost of administrative roles annually
- It would require accounting and legal assistance
A nonprofit organization is another form of business organization. However, just as the name depicts, the purpose of establishing it is not to gain profit.
The intention of establishing such organizations is to promote charitable or educational purposes. Any money earned by the organization stays within the organization and is used for carrying out the day-to-day programs and expenses of the organization.
Forms of business organisation: Nonprofit organisation
Establishing a nonprofit organization will also involve some paperwork as you might have to apply for tax exemption and even submit an application to the government so as to be recognized as a nonprofit organization.
Advantages of nonprofit organization
- They can exist even long after their founders are gone
- Offers an avenue for people to make significant impacts in society
- It provides protection from personal liability
- There is a tax exemption on net income
- They get funds from donations from individuals and organizations
- Employees may get benefits such as life insurance and discounts to health
- It brings together highly motivated individuals of like minds
Disadvantages of nonprofit organizations
- It takes much time and money to start
- The organization is likely to be subjected to public scrutiny
- No individual or shareholder receives profit from the organization
- Funding can be difficult sometimes
- Volunteers may be challenging to manage as they are likely not to be getting paid
Types of business
We have talked about the organization or business structures. These business organizations can come in different types - service, merchandising and manufacturing businesses.
This involves buying and selling of tangible products. Here, the business owner buys products at the wholesale price and sell at retail price.
This is the typical 'buy and sell' business we all know. Profit here is generated from the profit made after selling at a price higher than the cost price. A merchandising business sells a product the way it purchased it without having to change its form.
This is the type of business that provides intangible products in exchange for money. For instance, some firms offer professional skills, expertise, counselling etc. to customers and get paid for it.
Examples of service businesses are hairdressing salons, spas, schools, law firms, accounting firms, repair shops etc.
Unlike the merchandising business, there is a transformation of products in this type of business. Here, the company or business owner purchases raw materials with the intention of using them to manufacture a new product.
The production process in a manufacturing business involves labour, raw materials as well as overhead costs after which the finished product will then be sold out to customers.
Some businesses are designed to combine the features of the different types.
For instance, a restaurant or hotel business is manufacturing when it combines different ingredients to make wine; it is merchandising when it is selling a bottle of wine to a customer, and it incorporates service when it takes customers orders.